Chancellor Philip Hammond has been dealt a blow ahead of next month's Budget after the independent economic watchdog warned it was slashing growth forecasts.

The government’s economic forecaster has admitted it will need to “significantly” lower its estimates for the productivity of UK workers after a decade of stagnant growth since the financial crisis.

The Office for Budget Responsibility, whose forecasts form the basis of the chancellor's budget decisions, said the average rate of productivity growth of 0.2% over the past five years was a better guide for 2017 than its forecast of 1.6% in March.

The downgrade is is set to deplete the £26 billion headroom Mr Hammond had put faith in to ease the economy through Brexit .

It will also reduce the Chancellor's leeway to boost spending in the Autumn Budget, including on vital infrastructure and public services.

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Labour described the report as a “damning indictment of the last seven years of Tory economic failure”.

Shadow Chancellor John McDonnell said “the mounting evidence for a change of direction from the Chancellor couldn’t be clearer.”

He said: “We need no more proof that their austerity approach has failed to boost living standards or improve the long-term potential of the UK economy.

“Next month’s Budget cannot be another exercise in kicking the can down the road by Philip Hammond, we need to see substantial action.”

John McDonnell called the report 'a damning indictment of the last seven years of Tory economic failure' (Image: Getty)

The Treasury said it was working to fix the so-called productivity puzzle.

A spokesman said: "Productivity has been a long-standing challenge for the UK economy, which is why we are focused on boosting our performance to deliver higher living standards and build an economy that works for everyone."

The OBR said productivity had consistently fallen short of its forecasts, having dropped by 0.5% in the first financial quarter of the year and 0.1% in the second.